It is a story of the consequences of regulators who are captured by the institutions they are charged with regulating.
An owner in every home. It was the prosperous, 1990s version of the Depression- era “A Chicken in Every Pot.”
It was unheard of for regulators to team up this closely with those they were charged with policing.
Instead, in just a few short years, all of the venerable rules governing the relationship between borrower and lender went out the window, starting with the elimination of the requirements that a borrower put down a substantial amount of cash in a property, verify his income, and demonstrate an ability to service his debts.
A 1995 briefing from the Department of Housing and Urban Development did concede that the validity of the homeownership claims “is so widely accepted that economists and social scientists have seldom tested them.” But that note of caution was lost amid bold assertions of homeownership’s benefits. “When we boost the number of homeowners in our country,” Clinton said in a 1995 speech, “we strengthen our economy, create jobs, build up the middle class, and build better citizens.” Clinton’s prediction about the middle class was perhaps the biggest myth of all.
But what few have recognized is how the partners in the Clinton program embraced a corrupt corporate model that was also created to promote homeownership.
Fannie Mae became the quintessential example of a company whose risk taking allowed its executives to amass great wealth. But when those gambles went awry, the taxpayers had to foot the bill.
Perhaps even more important, Johnson’s tactics were watched closely and subsequently imitated by others in the private sector, interested in creating their own power and profit machines. Fannie Mae led the way in relaxing loan underwriting standards, for example, a shift that was quickly followed by private lenders.
Eliminating the traditional due diligence conducted by lenders soon became the playbook for financial executives across the country. Wall Street, always ready to play the role of enabler, provided the money for these dubious loans, profiting mightily.
Regulators across the country were either beaten back or lulled into complacency by the banks they were supposed to police.
The biggest benefit of its government association was the impression held by investors that Fannie was backed by the full faith and credit of the United States, a view that translated to far cheaper borrowing costs, fully one half of one percentage point for the company.
Along the way, he and his lieutenants would be able to enrich themselves on the government’s dime.
Meeting these targets required that the companies take an easier approach to what they considered acceptable underwriting standards from banks whose loans they would buy. Safety and soundness, the supposed goals of the legislation, took a backseat to politically driven housing goals. Down- payment requirements were the first to go. Traditionally, banks had required that borrowers put 20 percent of the property price
down to secure a mortgage loan, but the 1992 act encouraged Fannie and Freddie to buy mortgages where borrowers put down a nominal amount— 5 percent or less— of the total loan amount. Never mind that the risks associated with these loans were far greater; history showed that the more money, or equity, borrowers had in their homes, the less likely they would be to default on their mortgages.
Politics of Quasi- Government. “Fannie Mae was able to design its regulation.
Fannie’s biggest win involved capital requirements, which were set at levels far below those of other lenders— 2.5 percent versus the 10 percent demanded of banks.
Fannie was embracing a new world of riskier loans that would benefit Johnson, his protectors in Congress, and his paycheck. Those who stood to lose, because of the microscopic capital requirements that left Fannie unequipped to deal with its losses— taxpayers.
The regulatory issues in the 1990s will not be limited to safety and soundness, but will increasingly emphasize fairness: whether or not banks are fulfilling the needs of their communities.
Racial bias by mortgage lenders, Munnell and her colleagues wrote, not only existed, it was pervasive. The HMDA data showed that black and Hispanic loan applicants were far more likely to be rejected by banks than were whites. The rejection ratio for minorities was 2.8 to 1 compared with white applicants.
mortgages. To those inside Fannie Mae, the Boston Fed analysis was another threat to its political power. If banks were discriminating against minority borrowers, then Fannie Mae and Freddie Mac, the buyers of those mortgages, were by extension aiding and abetting the
With this action, Johnson created the centerpiece of what would, by the fall of 1994, become William Jefferson Clinton’s National Partners in Homeownership. The partnership’s strategy served Johnson’s goal by “making homeownership more affordable, expanding creative financing, simplifying the home buying process, reducing transaction costs, changing conventional methods of design and building less expensive houses, among other means.”
Underwriting flexibilities. New products. Expanding outreach efforts. All were code words for loosening underwriting standards and lending to people whose incomes, assets, or abilities to pay fell far below the traditional homeowner spectrum. No longer would Fannie Mae stick to its practice of ensuring that borrowers could meet their obligations and, therefore, that the loans it purchased carried relatively low risk.
After all, if bias were at work in minority neighborhoods, default rates in those areas would have been lower than among white areas, indicating that bankers were refusing loans to legitimate minority borrowers.
First to go was a reliance on credit history, an age- old method for measuring borrower risk.
Neither should relatively high expenses among low- income borrowers disqualify them from receiving loans.
Changes should also be made in down- payment requirements, the guide pointed out.
Mortgages using down- payment programs from municipal agencies and nonprofits would later demonstrate among the highest default rates.
In other words, a banker confronted with these new relaxed requirements could off- load any risky loans to the government- sponsored enterprises responsible for financing home mortgages for millions of Americans. For institutions concerned about having to hold onto questionable loans and possibly generate losses in them, the fact that they could sell them to Fannie or Freddie meant one beautiful thing: Any downside could be handed off to the government.
While some of those who dealt with Fannie thought that the company was forced to lower its standards by the prevailing political winds, some who worked inside the company contend that Johnson worked closely with the community groups to argue for relaxed lending.
We were never arguing that you should give loans to people who don’t qualify.” Still, that was the result.
Todd discovered that the change had been quietly inserted late in the legislative process by Christopher Dodd, the Connecticut senator whose constituents include most of the nation’s large insurance companies.
“Moral hazard” is the term used by economists to describe what Todd was talking about. If access to emergency capital made bank managers less likely to exercise caution, as they would if they could not expect help when experiencing losses, then that would be a moral hazard— it would encourage risk taking among banks because their executives knew they could be bailed out if they got into trouble.
Todd’s uncertainty about whether nonbanks would take on more risk would be erased some fifteen years later when the Fed rescued the world’s largest insurance company, the American International Group, providing $ 180 billion in taxpayer assistance.
Suddenly, supervision of the nation’s banks was being overseen by an organization viewed by many as a captive to the entities it regulated.
Looking to what a borrower could become— his credit future— had so much more potential.
Although banks were careful to make only those loans to people they felt certain would be “money good,” in Wall Street parlance, or able to repay their loans, these institutions did not always hold on to the mortgages they made. If the bank made a loan that it thought Fannie Mae, Freddie Mac, or the government’s Federal Housing Authority programs would buy, then the bank could sell it to one of those entities and free up that money to make another loan. Fannie and Freddie would then turn around and bundle thousands of these loans into mortgage- backed securities that income- seeking investors would buy. But if the bank could not convince Fannie or Freddie to buy a loan, it had to hold on to it and hope the borrower would pay it off.
Banks did not create pools of loans and sell them to investors like Fannie and Freddie did. They either sold them to the government or kept them.
In a little over sixty days, this obscure company had shifted almost $ 300 million of mortgage risks from its own books to those of investors. The following year, United Companies increased the size of its securities “shelf” to $ 3 billion.
Such was the risk that Duff & Phelps argued was reduced among loans made to sketchy borrowers. Because the loan approval process required of these borrowers was so much more onerous, the firm maintained, they would be far less likely to be able to refinance their loans if interest rates dropped. Getting a new loan might be a cinch for stellar customers, Duff & Phelps noted, but B& C borrowers had a harder time refinancing. Therefore, the risk that these mortgages would be repaid early was vastly reduced.
Investors would benefit twice, therefore. First, the income streams were larger because riskier borrowers were forced to pay higher interest rates on their obligations. Second, because these borrowers were locked in, prepayment risk was diminished.
At the time of its 1993 report, Duff & Phelps seemed simply to be making a persuasive investment thesis.
Pointing out the appeal of such loans to these and other investors helped unleash a boom that would be the downfall not only of the mortgage market but also of the entire mortgage securitization process.
Quantity, not quality, was rewarded by the firms providing the warehouse lines. And because those institutions buying the loans had to take the losses if they went bad, the bankers making the loans had less
incentive to ensure the borrowers were “money good.”
Watching the growth in securitization of B& C loans by United Financial and other upstarts, Fannie Mae grew worried about rising competition. Fannie Mae
was not allowed to own a mortgage underwriter, so it had to rely on the kindness of third parties to produce the loans that the company would buy. Johnson needed to ensure that such lenders would continue to send the lion’s share of their loans to Fannie Mae. An obvious solution to this problem involved cultivating a company that Fannie Mae already had a relationship with: Countrywide Financial.
His “friendship” with Johnson, Mozilo well knew, was driven by money. He had once characterized Johnson to reporters at Mortgage Strategy as so slick that “he could cut off your balls and you’d still be wearing your pants.”
Recognizing that Johnson needed him more than he needed Johnson, Mozilo forced Fannie to discount the fees it charged to guarantee the company’s loans it sold to investors.
But under the terms of Countrywide’s special deal, reported in the Wall Street Journal, Fannie charged the company only 0.13 percent of the loan amount. To keep its side of the bargain, Countrywide agreed to provide enormous volume to Fannie Mae and refused altogether to deal with Freddie Mac.
When interest rates began rising in 1994, slowing the wave of refinancing among prime borrowers, subprime lending gained even more traction as lenders saw that lower- quality borrowers could pick up some of the slack in the diminished prime loan arena. The fact that subprime loans could be significantly more profitable was icing on the cake.
Equifax Inc., one of the emerging leaders in credit scoring, introduced a system specifically tailored to assess the mortgage risk posed by a loan applicant. The system used information about a prospective borrower, applied different weightings to the data, and then predicted whether he or she would be likely to pay off the loan. It was novel and seen by the financial industry as a shiny new toy.
Perhaps most surprising was the regulatory response to the relaxed lending rules. Financial regulators either stood by as the old rules designed to promote sound lending were scuttled or, like the Boston Fed, actually encouraged their demise.
Under a new rule designed to streamline regulations, HUD said that lenders could hire their own appraisers, setting up the potential for inflated valuations.
But the partnership offices did more than simply provide ribbon- cutting celebrations for members of Congress and local elected officials. They also supplied jobs for relatives and former staffers of elected officials.
A former executive working closely with Johnson when the partnership offices came about recalled fears by some inside the company that the strategy would require Fannie Mae to back money- losing projects to satisfy local politicians. “When we started these partnership offices we were all afraid of what it meant— that we were going to politicize all our underwriting decisions,” he said.
But making such tax payments would also diminish Fannie Mae’s earnings and those of its executives.
“I knew I was taking on the behemoth, but it seemed only fair that they should pay a tax to the government that allowed them to operate, generating such profits,” Mr. Lightfoot said. “Their argument was they donated millions of dollars a year in charitable work to D.C. and that that should be counted in lieu of taxes.”
It would take another decade before HUD, Fannie’s “mission regulator,” would investigate the use of Fannie’s fifty- five partnership offices and conclude that their activities “were not confined to affordable housing
initiatives, rather, a central purpose of the Partnership Offices was to engage in activities that were primarily designed to obtain access to or influence members of Congress.”
“The focus on safety and soundness to the exclusion of any concern about their mission suggests to me that what we’re going to get is a result where safety and soundness become, not the primary but the exclusive focus at the sacrifice of our ability to do housing,” he said. In 2010, however, after concerns about the companies’ safety and soundness had been proven justified, Frank said: “I really have no recollection of that ’92 Act.”
Fannie Mae also made sizable contributions on more than one occasion and awarded its “Fannie Mae Maxwell Award of Excellence” at least twice to a Boston nonprofit group cofounded by Elsie Frank, the congressman’s mother.
A newsletter issued by the Committee to End Elder Homelessness thanked Frank for “working behind the scenes to open many doors for us to help achieve our goal.”
One of the most powerful instruments Johnson used in his protection strategy was the Fannie Mae Foundation, a charitable organization founded in 1979.
A big portion of foundation money went to advertisements about Fannie Mae and its advocacy of homeownership. In 1998, for example, the foundation spent $ 38.6 million on advertising. This was money that would otherwise come from Fannie Mae’s operations. As a result, tapping the nonprofit entity
to cover ad expenses helped boost the company’s earnings and its executives’ pay.
While most individual deductions had been eliminated in the Tax Reform Act of 1986, the mortgage interest deduction remained a sacred cow.
securities and sold to investors, the company touched fully half of all home loans originated across America.
The report concluded that Fannie and Freddie were an extremely costly way to help homeowners across America.
Moreover, CBO questioned Fannie’s and Freddie’s claims that if their federal charters were revoked, mortgage markets would become less stable and more volatile.
It was perhaps not a coincidence that a Minnesota Democrat would swoop into the hearing to defend Jim Johnson’s Fannie Mae. And it was classic Fannie to have others do its dirty work.
But the CBO report had succeeded in one important way— shifting the Fannie and Freddie dialogue away from total fantasy and bringing it one step closer to reality.
So, Wall Street firms like Bear Stearns and Lehman Brothers began offering warehouse lines of credit to Metropolitan and its rivals. Just as a lender for a paper mill, or any other manufacturer, provides loans for that manufacturer to fund their inventory until it is sold, banks and Wall Street expanded their credit- line commitments to these lenders so that they could originate a predetermined dollar amount of loans before packaging and selling them to investors.
While large banks and their large investment banking counterparties continued to see the mortgage- lending business as staid, conservative, and respectable, investment bankers at smaller firms like Lehman Brothers, Bear Stearns, Alex Brown, Oppenheimer & Co., and Friedman, Billings & Ramsey recognized that the changes in underwriting standards brought opportunities to package, pool, and securitize the loans and enrich themselves too.
Dealers submitting the borrower’s loan documents to their favorite finance companies knew they held considerable leverage over the lender.
Knowing that the loan would end up packaged and sold to investors unaware of how much due diligence had been done on it, the finance companies more often than not accepted the loans to meet the demand from investors buying their securitizations.
But even as the subprime auto finance lenders were vanishing beneath the waves, the subprime mortgage frenzy continued unabated.
But many investors failed to realize that, thanks to accounting rules, there was less to these companies’ results than met the eye.
In those days, accounting rules allowed companies that pooled loans into securities to recognize as income today what they expected the security to generate over the life of the pool. This was known as “gain- on- sale” accounting.
Since gain- on- sale accounting allowed them to book revenues on income that they had not yet earned, the companies were free to make their own assumptions about what they were likely to generate on their loans.
Cityscape Financial was one of the new crop of subprime lenders that was willing to lend a borrower more than 100 percent of a home’s purchase price. Operating in the United Kingdom but headquartered in the United States, Cityscape had sought to protect itself from the restatement risks that emerged if its borrowers refinanced their loans. Cityscape’s form of protection was to charge a very high prepayment penalty on borrowers to discourage them from refinancing and paying back their loans.
Silipigno admitted to falsifying loan schedules and bilking Bear Stearns out of $ 5.6 million. It was his way of dealing with tight market conditions and deteriorating loan performance.
How could Bear have done such a shoddy job of due diligence on the lender? How could Bear have been so lax about watching over its precious $ 200 million warehouse line? Ten years later, Bear’s shareholders would wonder the same thing, albeit on a much larger scale.
Banks and lawmakers had been chipping away at the Depression- era law known as Glass- Steagall for years, gradually eliminating the bits and pieces that had kept certain financial businesses separate from one another. But in the fall of 1999, the law
Although lawmakers Gramm, Leach, and Bliley had put their names on what was officially called the Financial Services Modernization Act of 1999, the law was really the work of a corporate empire builder named Sanford I. Weill. The chief executive at Travelers Group, an insurance company, Weill wanted to be able to merge its operations with Citibank, one of the nation’s oldest institutions, which was then run by John Reed.
Insurance companies were barred from operating under the same auspices as a commercial bank or investment firm.
He landed a cushy job as vice chairman of Citigroup, a post that some considered payback for his support in gutting Glass- Steagall.
With Glass- Steagall dead and gone, financial institutions were now free to grow large, extending their tentacles into the farthest reaches of both the nation’s and the world’s economies.
Now, however, there was nothing to stop a commercial bank from setting up an expansive proprietary trading operation that used the firm’s money to make bets. Gramm- Leach- Bliley allowed banks to cobble together all kinds of different, and risky, operations.
Its enactment, therefore, was a crucial step on the road to financial perdition known as Too Big to Fail.
the Federal Reserve Bank of New York, the most powerful regional bank in the Federal Reserve system, brokered a rescue of a huge and troubled hedge fund called Long- Term Capital Management.
As if this welcome message to financial risk takers was not enough, the Fed also began arguing for looser capital constraints on the nation’s banks during this tumultuous time.
This dilution came under the guise of giving banks more flexibility or making them better able to compete in international markets.
Rather than argue that bankers needed to be policed and ridden hard, Fed officials started to believe these executives could be trusted to do the right thing for the system, for their shareholders, and for themselves.
Greenspan was the chief proponent of the concept that self- interested individuals operate in ways that benefit an entire group. Therefore, he and like- minded people reasoned, they can be counted on not to act destructively. 2
These complex instruments had characteristics of both debt and equity. By allowing a debt instrument to be counted toward the least risky calculation of capital, this rule essentially allowed the banks to make their financial statements appear sounder than they were.
They resembled liabilities, after all, so if the bank that issued them got into trouble, its trust preferred holders would come ahead of other stockholders in recovering their investments. That would produce a deadly money drain at precisely the moment the bank needed to preserve its capital.
The Fed’s benevolent capital treatment for trust preferred securities not only increased risks in the banking system, it also had the unintended consequence of encouraging institutions to grow too big and difficult for regulators to unwind in a failure.
More important, the money that banks received when they sold these securities to investors helped fuel the mortgage lending boom that was on the horizon. By 2005, with that boom in full swing, TRUPS issuance stood at $ 85 billion, with more than eight hundred banks issuing them.
While OTS had barred finance companies like Greentree Financial and Metropolitan Mortgage from selling loans with prepayment penalties, the regulator eliminated that restriction in 1996.
Indeed, to make its earnings- per- share targets and trigger the all- important executive pay bonanzas, Fannie had had to resort to accounting fraud.
Federal investigators later found that you could predict what Fannie’s earnings- per- share would be at year- end, almost to the penny, if you knew the maximum earnings- per- share bonus payout target set by management at the beginning of each year. Between 1998 and 2002, actual earnings and the bonus payout target differed only by a fraction of a cent, the investigators found.
Instrumental in helping Fannie achieve these earnings and bonus targets was the company’s minimal capital requirement.
The result: 547 people shared in $ 27.1 million in bonuses. This was a record— the bonuses represented 0.79 percent of Fannie Mae’s after- tax profits, more than ever before in the company’s history.
Johnson was still on the Goldman board in 2010, when the Securities and Exchange Commission sued the investment bank for securities fraud relating to its sale of a dubious mortgage security. By that time, Johnson was earning almost $ 500,000 for his work on the Goldman board.
In actuality, his total compensation that year was more like $ 21 million, OFHEO said, referring to an internal Fannie Mae analysis it had turned up.
Just a month later, however, as Johnson prepared to leave the chairmanship of Fannie Mae to his trusted enforcer, Franklin Raines, another threat to the company arose. Clinton administration officials had begun discussing the merits of requiring the company to pay to register its securities. Fannie’s exemption from paying these fees was one of the valuable benefits reaped from its government association.
Never mind that the headline—“ Seeing a Fund as Too Big to Fail, New York Fed Assists Its Bailout”— couldn’t have been more accurate.
They could have raised margin requirements, for example, increasing the amount of their own money investors had to put up to buy stock using borrowed funds.
Unfettered capitalism coupled with the ownership society— where individuals were invited to participate in the wealth creation engine of the financial markets— had become a potent combination. It had produced riches for corporate executives like Jim Johnson and considerable wealth for individuals, and had replaced federal deficits with an unheard- of government surplus, generated largely from taxes paid by investors on their market gains.
The belief that the free market could police itself better than any government regulator had already taken hold.
This passage got to the heart of what the bankers— and by extension the Fed— had been pushing the Basel Committee to adopt: capital standards that were based upon internal risk assessments provided not by regulators but by the financial institutions themselves.
Top Fed officials ignored one of the most basic lessons in economics— that even though the sun may be shining today, you should set aside money for the inevitable rainstorm.
“The Fed’s worldview was dominated by the big banks,” the regulatory colleague said. “If you look back at all the things that were done, all the rulemaking was in the same direction— that the banks knew what they were doing and we needed to rely more on their internal systems.”
operations, routinely arguing that disclosure of its actions and deliberations could threaten the financial system.
The new framework devised by the committee changed the risk weightings that regulators would apply to these types of securities and the resulting capital requirements that the banks would have to set aside if they held them on their balance sheets.
In the increasingly complex world of mortgage securities the ratings agencies’ models were laughable for what they overlooked.
Until well after the rout in subprime mortgages had begun, Moody’s mortgage security model did not include information about a borrower’s debt- to- income ratio, one of the key predictors of default.
Subprime lending was already growing fast— between 1997 and 2000, HUD said, the number of home purchase applications backed by subprime mortgages more than doubled, from 327,644 to 783,921. Because such loans would be packaged and sold to investors, the banks did not need to worry about credit risks inherent in the loans.
Amazingly, regulators charged with overseeing the ratings agencies did not have access to detailed information about the types of loans inside the securities they were rating.
The American International Group would almost go bankrupt insuring these types of securities against default.
But even after it had become clear that the Fed had been wrong to push for relaxed capital standards, the regulator continued to take a pro- bank worldview in its various rescues of big banks hobbled by bad credit decisions. In 2008 and after, every Fed rescue, every Fed solution seemed designed to benefit the major banks at the expense of the taxpayers.
Victims described a process called equity stripping, where brokers persuaded them to refinance at such high costs that much or all of the equity they had built up in their homes disappeared into lenders’ pockets in the form of fees and service charges.
But he soon figured out what was behind the boom in predatory lending: Wall Street and its securitization machine.
Most significant, when Wall Street firms provided money to mortgage originators and then turned around and packaged those loans for sale to investors, they could argue that they had no idea the loans were improper.
Securitization meant predatory loans could be made and sold to investors with little burden or risk to those on the assembly line.
Their ideas would become the Georgia Fair Lending Act, a law designed to create consumer protections against high- cost home loans by restricting excessive fees and charges, and providing for penalties if the law was not followed. Those who knowingly broke the law could even face criminal charges.
tactic right out of the Fannie Mae playbook, the industry first claimed that the new law meant Georgia’s borrowers would no longer be able to secure a mortgage. Consumers, in other words, would be hurt by it.
The very companies that the Basel Committee, in its infinite wisdom, had blessed with new powers just a few years earlier were the ones that killed the Georgia Fair Lending Act, the most aggressive, pro- consumer law in the country.
Because of the state’s new Fair Lending Act, S& P said that it would no longer allow mortgage loans originated in Georgia to be placed in mortgage securities that it rated. Moody’s and Fitch soon followed with similar warnings. It was a critical blow. S& P’s move meant Georgia lenders would have no access to the securitization money machine; Standard & Poor’s said it was taking action because the new law created liability for any institution that participated in a securitization containing a loan that might be considered predatory. If a Wall Street firm purchased loans that ran afoul of the law and placed them in a mortgage pool, the firm could be liable under the law. Ditto for investors who bought into the pools.
Standard & Poor’s was correct about the Georgia law— those penalties it had mentioned were a legal design put in place by the law’s framers to thwart dubious lending. After all, if you eliminated the “plausible deniability” that securitization provided for participants in the loan pooling process, you would force players at each stop on the assembly line to increase their scrutiny of lending practices. By allowing liability for predatory loans to pass through to each participant in the chain, you could begin to slow down the securitization machinery that allowed fraudulent loans to wreak such havoc among poor and minority borrowers. In addition, such pass- through liability would allow wronged consumers to recover money damages even if the original predatory lenders went bankrupt or disappeared.
It would also protect investors by giving them a legal right to put back predatory loans to originators.
Not five months after it was enacted, the toughest consumer protection mortgage lending law in the United States was dead.
Subordinated debt issued by Fannie and Freddie was a prime example of the ratings agencies’ misplaced optimism.
But the ratings agencies rated Fannie and Freddie’s subordinated debt AA, just below the highest level.
the credit- ratings agencies that assessed the companies’ securities let investors know they were in no danger of losing money in a failure of either company.
Once again, this was a partnership based on mutual admiration and mutually received benefits. Fannie and Freddie were the largest private issuers of debt, exceeding even the combined balance of all fifty states, and the ratings agencies made enormous fees analyzing the companies’ debt and mortgage- backed instruments. Every time they issued a security, it had to be rated by two agencies. That meant the ratings agencies were extremely eager to please Fannie and Freddie.
The rating would be maintained continuously and S& P would report publicly if the financial strength of either Fannie or Freddie changed.
It was not until August 11, 2008, three weeks before Fannie was taken over by taxpayers, that S& P lowered Fannie’s risk- to- the- government rating. The ratings agency moved the grade from A + to A.
Enron’s collapse would be yet another black eye for all three ratings agencies. None of them had identified the risks that Enron had taken on— all had rated the company highly until four days before it imploded.
But because of the way these entities were structured, when Enron got into trouble, the risks they had held moved back onto the parent company’s balance sheet, sinking the entire operation.
First, they said, it is impossible to identify a con artist who is determined to fool investors.
A more important defense for the companies was their insistence that investment ratings were simply opinions.
With little in the way of competition, the agencies had no incentive to increase their staffs or improve their rating procedures. Moreover, their business models contained a deeply troubling conflict of interest.
If the ratings agencies were doing excellent work on behalf of the banks and Fannie Mae and Freddie Mac, they continued to do shoddy work for investors and taxpayers.
For as long as there were mortgage loans, prudent lenders had used debt- to- income ratios to measure how financially stretched a potential borrower was. For generations, this metric was a key predictor of mortgage defaults. Moody’s did not consider it to be crucial.
Indeed, the ratings agencies relied almost exclusively on data provided to them by issuers rather than demanding that the loan packagers provide the information the agencies needed. Just as Fannie and Freddie had disavowed their government guarantee even as they capitalized on it, the rating firms were acting as advertisers while claiming to be investigative journalists.
They would be likely to downgrade only when loan woes became clear and apparent.
Those who argued that Fannie and Freddie were thinly capitalized and poised to create some future crisis were fear mongering,
In 2001, however, Fannie took its accounting chicanery to new heights, or lows, depending upon your perspective. And it did it with the help of its favorite investment bank, Goldman Sachs.
In 1999, Goldman had returned the favor of a directorship by offering a seat on its prestigious board to Jim Johnson. It was a classic example of the “I’ll- scratch- your- back, you- scratch- mine” mentality among corporate boards.
The year Johnson became a director at Goldman, Henry M. Paulson Jr., the man who would oversee the taxpayer bailout of Fannie Mae as Treasury secretary in 2008, took the helm at the investment bank.
Because Goldman did not have a nominating committee at the time, Johnson’s appointment to its board was a decision made at the highest levels of the firm.
All of the corporate executives who invited him onto their boards seemed to recognize this— Johnson chaired the compensation committees of every board he sat on over the years. 1
“A financial institution’s direct interdependencies exist through explicit contractual arrangements with other parties— loans, financial derivatives, or credit insurance, for example— that expose the institution to counterparty risk,” the paper stated. “If a significant number of interdependent institutions incur losses or fail simultaneously, uncertainty about the prospects of the remaining firms, even the solvent ones, and about the likely responses of other investors in those firms, will also increase. This may make it difficult for the remaining solvent institutions to issue debt.”
But the head of OFHEO had not simply attacked Fannie and Freddie, he had also directly threatened the fastest- growing business on Wall Street: the sale and trading of derivatives, including credit default swaps.
Less than twenty- four hours later, the Bush White House demanded Falcon’s resignation. In his place they would nominate Mark C. Brickell.
Johnson was an early initiate to the VIP Program. Starting in 1998 and continuing through 2007, Johnson received six cut- rate loans from Countrywide worth a total of more than $ 10 million. 1
With more than thirty- five thousand employees, it was easy for Mozilo to make a few strategic hires for friends and others in positions to help Countrywide.
Obsessing about market share meant that as Countrywide’s rivals corrupted their lending practices, it would have to do so as well in order to compete.
Mozilo’s second mistake was relying on investors to finance his securities; this made his company exceedingly vulnerable to a turning off of the cash flow, unlike banks, which used their customers’ relatively stable deposits to make loans.
Add in Mozilo’s arrogance and the mix became ultra- combustible, not only for his company but for the financial system as a whole.
Instead, borrowers were led to high- cost loans that resulted in rich commissions for Countrywide’s smooth- talking sales force, outsized fees to company affiliates providing services on the loans, and a roaring stock price that made Countrywide executives among the highest paid in America. Such loans carried punitive prepayment penalties or had interest rates that were set alluringly low at first, only to skyrocket in a few years’ time.
For all of Mozilo’s talk of wanting to help minorities and low- income people secure a mortgage, the company’s systems were designed to increase costs for precisely these borrowers, former Countrywide employees said.
One former mortgage broker in Los Angeles said that Countrywide branches in upscale neighborhoods like Beverly Hills and Santa Monica had to slash their mortgage rates to be competitive with rival banks. But in areas that were predominantly minority, Countrywide’s rates were far higher because company executives knew borrowers in these neighborhoods had few if any alternatives.
“The typical borrower for a subprime mortgage reads at the sixth- grade level or below,” Gnaizda said, “and that is part of why these instruments were devised. As Alan Greenspan informed us in 2004 when we presented the Countrywide instruments in detail, he said even if you had a Ph.D. in math, you wouldn’t be able to see what was helpful or harmful.”
Fannie Mae’s primary objective from the “outreach strategy”: to “deepen relationship at all levels through CHL and Fannie Mae to foster alignment and collaboration between our companies at every opportunity.”
The program was a success. In 2005, Countrywide sold $ 12.7 billion in subprime loans to Fannie Mae and was its second- biggest supplier of what would turn out to be highly toxic paper.
By the first half of 2006, almost two thirds of the subprime loans underwritten by Countrywide had loan- to- value ratios of 100 percent; that meant borrowers had put no money down to secure the property.
The brokers who brought these problem loans to Countrywide had a time- tested system for making sure they progressed smoothly through the Countrywide machinery. Envelopes stuffed with thousands of dollars in cash would be hand delivered by some brokers each month to the account managers responsible for seeing that the loans actually closed.
The stereotype of the twenty- six- year- old mortgage broker driving a red Ferrari and living in a $ 1.5 million house existed for a reason— there were loads of them.
Like others in the subprime industry, Hartman and Anderson used aggressive accounting practices that allowed losses on loans made yesterday to be hidden by new mortgages originated today.
Hoping to profit when suspecting fraud or dubious practices at a company, short sellers borrow its shares in the open market and sell them to a buyer. Known as selling short, the strategy is profitable only if the stock price falls. Then the short seller repurchases the shares for less than he received when setting up the trade, capturing the difference. Once he buys back the shares, they are returned to the brokerage firm from which they had been borrowed.
Selling short is the opposite of buying shares, or going long in Wall Street parlance, but it carries far greater risks.
Investors who own shares in companies targeted by short sellers often call them un- American.
Among the questionable corporate practices that are the easiest to find are those that appear in a company’s own financial statements, right there in black and white. With a little determination and expertise, accounting practices that burnish financial results or make earnings appear out of thin air can often be spotted in these publicly filed documents.
A second type of arithmetic used by NovaStar allowed it to record immediately all the income that a loan would generate over its decades- long life. This accounting method completely ignored the possibility that some of the company’s loans might default and fail to pay off. Although most companies using this method— known as gain- on- sale accounting— estimated that some portion of the loans would not be repaid, NovaStar assumed that losses on all of its loans would be nonexistent.
NovaStar did not worry about conducting the kind of due diligence on its mortgages that was typical of lenders who held on to their loans. So what if the loans failed later? Generating more loans meant more fees now.
NovaStar’s branch system, HUD said, was designed to shift risk from the company to the federal government.
But NovaStar’s cofounders did just fine. Between 2003 and 2008, both Anderson and Hartman made $ 8 million in salary, bonuses, and stock grants. Neither man was ever sued by the SEC or any other regulator.
“Housing in the New Millennium: A Home Without Equity Is Just a Rental with Debt.” 1
Contrary to Greenspan’s assertion, the millions of borrowers who were rolling car loans and other revolving credit obligations into their mortgages were engaging in a classic investment mismatch, using long- term debt to buy assets with a short- term life.
Two elements contributed to this uniformity: the automation of mortgage underwriting in the United States during the late 1990s and the consolidation of firms writing home loans.
While accounting may seem excruciatingly boring to many, it has also proven to be a battleground where those wishing to obfuscate fight against believers in transparency. Such a battle was waged and lost in 2003 on the matter of off– balance sheet entities, a major contributor to the investor losses in the credit crisis that began three years later.
Citigroup was always on the prowl for acquisitions because its massive size meant that internal operations could not produce the earnings growth demanded by investors.
Only mergers with other large companies could move the profit needle for Citi.
cost of debt,” Greenspan said. “I should emphasize that Fannie and Freddie, to date, appear to have managed these risks well and that we see nothing on the immediate horizon that is likely to create a systemic problem. But to fend off possible future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventive actions are required sooner rather than later.”
In early 2011, it came out that taxpayers had paid $ 24.2 million in legal costs so that Raines, Howard, and Spencer could defend themselves in shareholder suits. It was an insult added to a decidedly grievous injury.
were pouring into the pools. So instead of turning them back to the lenders who had made them, demanding that they be replaced with solid loans, the nation’s top brokerage firms used the dubious mortgages as a lever to wring more profits for themselves out of the originators.
It was another example of Wall Street turning lemons into lemonade, for itself anyway.
Armed with loan statistics provided by these samples, Wall Street’s investment banks saw in late 2005 and throughout 2006 that the mortgages they were financing and selling to investors were becoming increasingly sketchy. They did not share this information with the investors who bought the pools they were selling, however. Instead, the firms started forcing the lenders producing the diciest loans to accept a lower price for them. Wall Street knew they had the lenders in a box— NovaStar and New Century did not have the capital they needed to buy back troublesome loans, so the lenders were only too happy to sell what were called “scratch- and- dent” mortgages more cheaply to the brokerage firms, who then pooled them into securities that were sometimes sold as pristine.
Rather than pass these discounts on to their customers buying the loan pools, some firms charged the same high prices associated with superior loans. Never mind that pushing these perilous mortgages through the securitization machine guaranteed early and substantial losses for their clients.
The firms should have either turned back the loans to the originators or charged investors less for them to make up for the additional risks they posed.
Goldman Sachs’s internal response to these due- diligence reports is especially intriguing because, unlike many other firms, it went negative on the mortgage market in the fall of 2006, well before others in its industry. Using its own money, the firm began amassing major bets against the same dubious loans it was peddling to investors at that time. Goldman, therefore, profited immensely from the losses its clients absorbed, losses its own practices helped to create.
The relationship forged by Wall Street’s most prestigious firm, Goldman Sachs, with one of the nation’s most wanton mortgage originators— Fremont Investment & Loan— is a case in point. Fremont, a company with a regulatory rap sheet and a history of aggressive lending, received $ 1 billion in financing from Goldman in 2005, fully one third of the total it received from all of its Wall Street enablers.
Goldman had begun financing Fremont in 2003 with a credit line of $ 500 million, but as the mortgage spree ramped up, it doubled that commitment. Goldman did so in spite of a serious run- in Fremont’s insurance unit had had with regulators just five years earlier.
The photograph collection sent a message to Fremont’s visitors that this was not just any financial concern— this was a classy enterprise that paid close attention to detail. When Fremont failed almost forty years later, the artwork would become enmeshed in a fierce battle over Fremont’s assets.
Fremont Investment and Loan was insured by the FDIC and had relationships with many Wall Street bankers. A “no- frills” institution that offered certificates of deposit and money market accounts but shunned the more prosaic businesses of checking or savings accounts, Fremont generally held on to the commercial loans it made. The residential mortgages it made were quickly sold to investors.
The secret scheme was orchestrated at the highest levels of Fremont General, regulators said; it was led by Rampino.
Before the scheme was hatched, Fremont’s insurance would cover up to $ 1 million on each workers’ compensation claim it received.
Anything over that amount would be borne by the reinsurance companies Fremont had contracted with.
The Federal Reserve Board’s decision to slash interest rates to propel the economy was hurting investors who lived on the income generated by their holdings.
Mortgages, with their relatively higher yields, provided a handy answer to this problem. Many investors, notwithstanding Subprime 1.0, still believed that home loans were relatively conservative instruments. Ratings agencies, blessing the majority of these securities with triple- A ratings, only confirmed this rosy view.
Mortgage originations had been propelled by the Fed’s rate cuts, but with prevailing rates at 1 percent, there was little room for further declines. This was meaningful because borrowers who had reached for more home than they could afford would no longer be able to lower their costs by refinancing when rates fell again.
Wall Street bankers were desperate to halt the decline in mortgage volumes, which spelled disaster for bonuses and even presaged the unthinkable: layoffs.
This meant putting their own interests ahead of their clients’ at every turn. While nobody mistook Wall Street banks for charity organizations, the degree to which these firms embraced and facilitated corrupt mortgage lending was stunning. Their greed and self- interest took the mortgage mania to heights (or depths, depending on your view) it could not possibly have reached without Wall Street’s involvement. And in so doing, Wall Street helped propel world financial markets to the brink of collapse.
The voraciousness of these firms would also push the nation’s economy into its most serious recession in more than seventy- five years. Their avarice would finally, and forcefully, demonstrate how a noble idea like homeownership could be corrupted into something that so poisoned the global economy it was left in a semi- vegetative state.
and best house for the buck. Interest- only mortgages were just the ticket.
What many borrowers did not want to understand was that by avoiding paying down any principal on their loans, they were not building up any equity in their homes. By not paying down principal, the size of the mortgage remained the same.
These mortgages were known as negative amortization loans because the amount of interest a borrower chose not to pay would be tacked on to the principal owed, increasing his total loan balance. Instead of amortizing or paying down the loan, it grew in size.
Imagine how tempting it was for borrowers facing stagnant incomes to pay a fraction of their loan’s interest every month! To make their gambles pay off, they needed home prices to keep surging, or win the lottery with a portion of their deferred payments. As it turned out, winning the lottery would have been easier.
By creating these loans, which piled new consumer debt on top of old, Wall Street’s bankers had done something entirely new and nefarious. They had allowed institutions extending credit to consumers in the form of a second mortgage or home equity line of credit to share in the collateral backing all the loans without asking for permission from lenders who were there first and thought they were the sole creditors. This was unheard of among corporate lenders, for example, who required that anyone providing money after an initial loan was made to a company would take a backseat position to the bankers who were there first if the loan went bad.
The way mortgage securities are structured, if you cannot find buyers for the lower- rated slices, the rest of the pool cannot be sold.
Wall Street has a term for this— it’s called putting lipstick on a pig.
In this case the lipsticked pig was the collateralized debt obligation, a pool that contained pieces of other mortgage pools.
all mortgages, all the time. All benefits of diversification had vanished; now the portfolios were dangerously concentrated and synchronized.
If Wall Street worried that the ratings agencies would notice this and penalize the securities on their ratings scales, it needn’t have. Because grading complex products was so much more lucrative than rating a simple corporate debt issue, the agencies welcomed the business and promptly began assigning improbably high marks to these instruments.
Moody’s could earn as much as $ 250,000 to rate a mortgage pool with $ 350 million in assets, versus the $ 50,000 in fees generated when rating a municipal bond of a similar size.
Fitch, Moody’s, and S& P paid their analysts far less than the big brokerage firms did and, not surprisingly, wound up employing people who were often looking to befriend, accommodate, and impress the Wall Street clients in hopes of getting hired by them for a multiple increase in pay.
Their failure to recognize that mortgage underwriting standards had decayed or to account for the possibility that real estate prices could decline completely undermined the ratings agencies’ models and undercut their ability to estimate losses that these securities might generate.
Given that CDO managers were eager participants in the scheme, there was no quality- control mechanism to ensure that garbage stayed out of these instruments.
With the good performance of the CDOs in a still- hot market, the ratings agencies began to grade the managers and based their ratings on the simple notion that those who managed the most deals must be the best.
But CDOs had another, major allure for the Wall Street firms that peddled them. Because of the way they were structured, they allowed the firms who were selling them to bet against the clients buying them.
But after Goldman gave up its private partnership structure, raising money from the public in 1999, the tone at the company changed. Profits took priority over customer care and trading desks soon dominated the firm’s previous power center— the investment banking arm.
Lloyd Blankfein, a commodities trader who joined the firm when it bought J. Aron and Company, a trading house, was a driver of this shift at Goldman. He became its chief executive when Paulson left for Treasury.
Given that traders were in control at Goldman, it is not surprising that the firm’s mortgage desk convinced top company officials to make a major bet against the home- loan market.
Recognizing that the market was overheated and starting to cool, Goldman quietly began wagering against the very securities it was selling to its clients.
With CDO managers lapping up all manner of mortgages, lenders soon found that their production targets were harder and harder to achieve. Countrywide, NovaStar, Fremont, and the rest responded by ramping up the profits generated in each loan. This meant steering borrowers who would otherwise qualify for lower- cost mortgages into highly profitable but much more toxic loans.
Mortgage brokers peddled them as easy and hassle- free. These and other tricks hurt borrowers. But they increased the industry’s and investment banks’ profits.
Sure, the lies were the borrowers’ ideas in some cases, but the pressure to originate volume caused some lenders to falsify borrowers’ mortgage applications routinely.
The face of banking had changed; regulators and lenders now spoke of caveat emptor, let the borrower beware, when it came to lending practices.
Why should bankers have to consider which mortgage product was really the best for the customer? It was better to let bankers innovate, creating a variety of products from which borrowers could choose.
Besides, regulators argued, even if they wanted to police these loans, most were made by unregulated mortgage firms. Never mind that they were funded by the institutions that were, in fact, supposed to be regulated.
Behind these creative bankers stood an increasingly powerful participant in the game: mortgage- backed securities traders employed by major investment banks.
Credit risk officers were stick- in- the- muds, naysayers generating only costs, while mortgage traders were central to the firms’ profits.
To traders, this business was not about homes, borrowers, or the American Dream. Sweet as those notions were, they were secondary to the pieces of paper a trader could move and the gains those transactions generated. Besides, who needed a risk manager when you were operating in a market that only went up?
While a bank that held a loan cared deeply that it would be repaid, investors in mortgage- backed securities were more interested in avoiding the lost income that resulted when a borrower prepaid his loan.
While these changes hardly seemed worthy of an upgrade, the volume of loans that Fremont churned out meant big fees for ratings agencies. Perhaps Fitch’s upgrade had more to do with the future business Fremont might throw its way; after all, Fremont was servicing more than 100,000 loans totaling $ 19.1 billion in principal balance at the time and was projecting a servicing portfolio of $ 24 billion by the end of 2005.
Were Fremont’s bankers, Goldman Sachs and others, beginning to fret about the warehouse lines they had so generously given the company? The big increase in securitizations suggested that Fremont’s lenders were pressuring it to get more mortgages out the door to investors so the financiers could get their money back before the roof caved in.
But with the time between origination and securitization shrinking, the risks that those mortgages would lose money for the bank also shrank
The existence of the reports did help Wall Street promote its mortgage pools. Selling documents for these securities noted that such analyses had been conducted, providing some assurance to investors that the pools had been reviewed and scrubbed, and were in some cases, as much as 60 percent of an entire mortgage pool was showing material defects in underwriting. Even worse, these defects had no offsetting factors, such as outsized borrower cash reserves.
Forcing the loans back on the lenders’ books, given the lines of credit the bankers had extended, could easily push some of them off the cliff and take the investment banks’ money with them.
Faced with the choice of profits or propriety, Wall Street made its decision.
Closing their eyes to the problem loans, the banks kept feeding them into the mortgage machinery. But before they did so, the banks made sure the lenders cut them enormous discounts on the cost of the loans. These discounts were not passed along to investors; they simply increased the profits earned by the investment banks on the garbage loans.
An investor could easily overlook fourteen little words buried in a several hundred– page prospectus.
In September 2006, regulators tiptoed into the subprime lending morass, issuing new guidance, not regulations, on so- called nontraditional mortgage products. Once again, the overseers were a day late and many dollars shy with their tepid announcement. The sum total of the guidance was to warn lenders to “consider” the ability of a borrower to make payments over the life of the loan and not just at the introductory or “teaser” rate.
But it was finally becoming clear to regulators and investors that lenders like Fremont had become reckless beyond words. Investment banks, meanwhile, decided to take the wheel of the listing subprime ship.
Desperate to save their reputations and the billions they had committed to build extensive trading platforms, securitization, and origination factories (not to mention warehouse lines), they started becoming much more involved in the operations.
“Early payment defaults,” as they were known, allowed investors in the mortgage securities to return the loans to the lender and, in exchange, get their money back. If the lender didn’t have enough money to repurchase the defective loans, the investment bank that provided the lines of credit to the lender could be forced to pay.
In a 2007 report from Moody’s, Fremont’s loans would be deemed worst in class. Never mind that just a year earlier, Moody’s had assigned high grades to securitizations stuffed with the very loans the ratings agency now questioned.
Wall Street used its leverage and inside information about the souring loans to make claims on the lenders’ assets before mortgage investors beat them to it.
So in the third quarter of 2006, the firm decided to make a concerted effort not only to rid itself of any mortgage assets it had on its books, it also decided to make a very big wager against the subprime sector as a whole.
Goldman didn’t stop selling mortgage securities stuffed with sketchy subprime loans to its clients, mind you. Indeed, in the first three quarters of 2006, Goldman sold $ 17.8 billion of its own mortgage- backed securities; it also sold $ 16 billion in CDOs, up from $ 8 billion in 2005.
The firm seemed to view its customers not so much as people to watch out for, but as trading partners it could take advantage of if they were foolish enough to allow it. Savvy investors knew enough to approach warily any securities Goldman was peddling.
Even so, S& P’s and Moody’s financial engineering justified triple- A ratings on five slices of securities backed by Fremont mortgages in the deal.
While Goldman’s salespeople were busy bundling and selling as many Fremont loans as they could, executives inside the firm were scurrying to off- load mortgages that were still on their books. It was a race against time inside Goldman in early 2007, as internal e- mails produced to Congress show. The paramount goal was to get rid of toxic mortgages.
In early February, Josh Rosner and Joseph Mason presented a lengthy paper2 at The Hudson Institute, a Washington think tank, warning of coming losses to holders of mortgage securities, and as a result, the end of credit availability to the housing market. The banks rejected the analysis even as they were quietly jettisoning those very securities from their own books.
Nevertheless, by the end of that month, Goldman had packaged and sold to investors more than $ 1 billion in mortgage securities backed by Fremont loans. It had also placed internal bets against the same Fremont loans it was selling to its customers.
If the rate of early payment defaults kept rising, it would be only a matter of time before the firms collapsed under the crushing capital calls.
At the same time, Fremont was visited with a cease and desist order from the FDIC, a regulatory action that was the kiss of death for a financial institution. The FDIC enumerated fourteen problematic practices at Fremont, including operating without effective risk- management policies and with a large volume of poor- quality loans, and conducting business without sufficient capital or liquidity.
The laundry list of ills was so voluminous that it suggested that Fremont’s bank examiners had, like Rip Van Winkle, been asleep for years. But the biggest blow to Fremont came in the FDIC’s requirement that it shore up its capital and reserves to cover possible losses on its loans. Fremont was in a bind. Investors knew the company could not cut originations and generate enough capital to meet the FDIC’s demands.
Fremont began selling to investors loans that were languishing on its books.
operations. Its employees sued Fremont, claiming that it had improperly filled employee retirement accounts with Fremont stock, which had cratered in value. In their suits, employees noted that James McIntyre, Fremont’s chairman and the founder’s son, had astutely sold $ 11 million of his stock during the summer of 2006. Fremont directors had sold $ 5.5 million in 2007. If Fremont was really a sound and suitable investment for the little people, why was management running for the hills? 3
Fremont was certainly dying; its condition was terminal. Just as its mortgages had become a cancer on the communities it had supposedly served, the company itself was riddled with cancerous loans it was being forced to buy back. The patient would linger on life support for another year.
In April 2008, Fremont announced that it received default notices on over $ 3 billion of subprime mortgages it had originated in March 2007 and that it did not have the cash to buy back the loans as promised.
That month, with Fremont’s stock in the cellar and its operations all but shuttered, the ratings agencies finally downgraded Fremont. They assigned the company’s debt the ignominious status of junk.
After the bankruptcy was wrapped up, some vestiges of Fremont— mostly the rights to tax benefits generated by the company’s massive losses— were taken over by a company called Signature Holdings. James McIntyre is no longer involved in the company his father had founded forty- five years earlier.
The economic crisis of 2008 actually created the ultimate public- private partnership. With the collapse in mid- March 2008 of Bear Stearns, the scrappy but venerable investment bank, the government stepped in to help resolve a private failure. The Federal Reserve Bank of New York, led by Geithner and joined by Paulson at Treasury, brokered a shotgun marriage of Bear Stearns to JPMorgan Chase.
It was the first major demonstration that the government would not allow a brokerage firm, whose reckless lending and leverage had sown the seeds of its own destruction, to go bankrupt. Bear Stearns executives had taken in all the profits of their disastrous practices but when the due bill arrived for these activities, it was the taxpayers’ obligation.
Even as Fannie and Freddie sped toward insolvency in 2008, Jim Johnson held sway in Washington. No one seemed to connect him and his years at Fannie’s helm with any of the problems that doomed the company.
The irony of having two of the nation’s most strident defenders of Fannie Mae sponsoring the new reform act was lost on few of those who knew the entire sordid Fannie story. And yet the law failed the most basic test— it did not insist that large and unmanageable institutions be cut down to size to alleviate their threats to taxpayers in the